Recent policy signals give a clearer indication of the future evolution of China’s pensions system, which is set to quadruple in size over the next decade, reaching a total value of RMB28trn ($4.4 trn) by 2020, according to Z-Ben Advisors.
Since the downsizing of China’s state-owned enterprises in the 1990s and the dismantling of the Maoist “iron rice-bowl” welfare system, China’s pensions system has been unable to keep up with the country’s rapid economic growth. The demographic structure created by the one-child policy, with the dependency ratio steadily ticking upwards, also poses a significant challenge to Beijing’s ability to ensure pensions coverage going forward.
Public pension funds (PFPs), traditionally the primary source of retirement income, have been limited in their investment options, meaning the overwhelming majority have struggled to deliver positive returns against backdrop of steady - and occasionally high - inflation.
As China seeks to boost domestic consumption within the economy and liberalise its financial markets, profound changes lay ahead for its pensions system. According to Z-Ben, the two major trends are centralisation and privatisation.
“Currently, the system is fragmented into towns or cities, which is a real obstacle to pensions system development and puts people off paying into plans. If the system is not centralised, the level of risk associated with Chinese pensions systems development will certainly increase,” David Willis, one of the report’s authors, tells IPA.
Poor returns and management issues have also deterred citizens from paying into PFPs and many have opted out of pensions provision in the last decade. China’s emerging middle class have preferred to take out private policies, leading to rapid growth of the private sector and creating an entirely new source of opportunities for asset managers.
Willis adds: “For most Chinese, their individual accounts are basically empty because the funds have been used to cover previous liabilities. There definitely needs to be more information and education to reassure pension holders that they will get something upon retirement.”
Restrictions imposed on the National Social Security Fund have hindered performance, while liabilities are set to increase as demographic structures change, giving policy-makers a strong incentive to liberalise investment options. Among the most significant reforms in this area are moves to bring provincial pensions funds under the management of the NSSF and increase active management.
Given China’s size, low participation rates have not prevented the accrual of significant pensions assets. By 2011, China’s total pensions assets had reached nearly RMB7trn, according to Z-Ben. This is comprised of RMB2.05trn AUM in PFPs, RMB920m NSSF AUM, and RMB4.08trn AUM in private insurance schemes. There is also a small but growing EA segment.
In order to improve returns on these assets, Z-Ben argues the government will continue to increase the investable quotas for all types of pensions funds, while also allowing greater diversification into riskier and alternative assets as they attempt to improve returns.
“The NSSF has posted very good returns considering the limitations imposed on it and the current investment climate. If they had access to more investable assets, that would certainly be a positive. They could also expand further into non-core assets, particularly private equity,” Willis says.
For financial institutions, this means a steady expansion of opportunities, the report concludes, particularly those with solid track records and pension fund management experience. There will also be greater scope for specialisation, and mandate opportunities will differ according to the type of firm.
For example, the NSSF is the only entity able to release RFPs to the public, meaning fund managers looking for EA mandates should approach custodian banks or EA trustees, the report points out. Insurers can currently only outsource asset management functions to insurance AMCs, but over time external AMCs may also be allowed into this space, it speculates.
Fund managers may occasionally express frustration with the slow pace of reform. But Z-Ben argues that, despite current restrictions, there is likely to be an expansion of opportunities to a wider range of financial institutions as China’s modernisation of its pensions system continues.
This may require patience, but given the rapid rise in liabilities that China’s demographic structure will create in the near future, even the most recalcitrant political elements will be forced to accept liberalisation and greater risk exposure for pensions fund - because the consequences of inaction will be even harder to stomach.